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FX Forecast Update January 2012: Euro Pain - Stocky Gain

Main forecast changes

EUR/USD: Eurozone money market rates are expected to fall further and as a result we have opted to lower our 3M EUR/USD forecast to 1.26 from 1.28. We still look for improved global macro data to weaken the dollar during 2012, but elevated eurozone debt risks and the outlook for further ECB monetary easing means there is less potential for dollar weakness against the euro. As a result, we have lowered our 12M forecast to 1.34 from 1.38. While we do see potential for a higher EUR/USD later in 2012, as record short EUR positions are reduced, we still recommend hedging euro downside. The decline in implied volatility over the past month has made hedging via options more attractive.

Scandies: Quality is paying off. Even though the global business cycle is on the defense, SEK and NOK continue to trade on a strong note. We think local fundamental factors will be a dominating theme also in 2012, which suggests the medium-term downtrend in EUR/SEK and EUR/NOK remains intact - as reflected in our 8.50 and 7.50 12M forecasts. That said, neither EUR/SEK nor EUR/NOK have decoupled from cyclical factors and since we look for a batch of weak figures from Sweden going forward, we continue to see a risk for a short-term correction higher in EUR/SEK. Our 3M forecast is 9.00.

EUR/CHF: The resignation of SNB Governor Hildebrand has prompted the question as to whether the SNB will continue with its previous policy. However, while EUR/CHF has traded lower and the option market has priced in a higher probability of a break of the 1.20 floor, a true investor test of the minimum target has not been seen. We expect the SNB to continue with its previous policy and hence continue to forecast EUR/CHF above 1.20 during 2012. A hike of the minimum target has become less likely, however, and we have opted to lower our 3M forecast to 1.21 from 1.24.